International Exchange Forex IXFX Currency Markets

- The purpose of this report is info on International Exchange Forex (acronym: IXFX) on forex market trading. As with many markets there are many
derivative of the central market such as commodity futures and optionss. For the purpose of this report
we will only be discussing the main market sometime
referred to as the FX Forex Spot market or Currencies Cash market.

The word FOREX is an acronym for Foreign Exchange and
is the largest financial market in the world. Unlike
many markets the FX market is open 24-hours per day
and has an estimated $2 Trillion plus in turn-over every
day. This tremendous turnover is more than the combined
turnover of all the worlds stock markets on any given
day. This tends to lead to a very liquid market and
thus a desirable market to trade.

Unlike many other securities (any financial instrument
that can be traded) the IXFX market does not have a
fixed exchange. It is primarily traded through banks,
brokers, dealers, financial institutions and private
individuals. Trades are executed through phone and
increasingly through the Internet. It is only in the
last few years smaller investors has been
able to gain access to this market. Previously the
large amounts of deposits required precluded the smaller
investors. With the advent of the Internet and growing
competition it is now easily in the reach of most
investors.

You will often hear the term INTERBANK discussed
in FX terminology. This originally, as the name implies
was simply banks and large institutions exchanging
information about the current rate at which their
clients or themselves were prepared to buy or sell
a currency. INTER meaning between and Bank meaning
deposit taking institutions normally made up of banks,
large institution, brokers or even the government.

The currencies market has moved on to such a degree now
the term inter-bank now means anybody who is prepared
to buy or sell a currency. It could be two individuals
or your local travel agent offering to exchange Euros
for US Dollars. You will however find that most of
the brokers and banks use centralized feeds to insure
reliability of quote. The quotes for Bid (buy) and
Offer (sell) will all be from reliable sources. These
quotes are normally made up of the top 300 or so large
institutions. This insures that if they place an order
on your behalf that the institutions they have placed
the order with is capable of fulfilling the order.

Now although we have spoken about orders being fulfilled,
it is estimated that anywhere from 70%-90% of the
FX market is speculative. In other words the person
or institution that bought or sold the currency has
no intention of actually taking delivery of the currency.
Instead they were solely speculating on the movement
of that particular currency market.

Source: Bank For International Settlements.
Extract From The Triennial Central Bank Survey of
Foreign Exchange and Derivatives Market Activity.

Currency

1989

1992

1995

1998

2001

US Dollar

90

82.0

83.3

87.3

90.4

Euro

.

.

.

.

37.6

Japanese Yen

27

23.4

24.1

20.2

22.7

Pound Sterling

15

13.6

9.4

11.0

13.2

Swiss Franc

10

8.4

7.3

7.1

6.1

As you can see from the above table over 90% of all
currencies are traded against the US Dollar. The four
next most traded currencies are the Euro (EUR), Japanese
Yen (JPY), Pound Sterling (GBP) and Swiss Franc(CHF).
As currencies are traded in pairs and exchanged one
for the other when traded, the rate at which they
are exchanged is called the exchange rate. These four
currencies traded against the US Dollar make up the
majority of the market and are called major currencies
or the majors.

Market Mechanics

So now we know that the FX market is the largest
in the world and that your broker or institution that
you are trading with is collecting quotes from a centralized
feed or individual quotes comprising of inter bank
rates. So how are these quotes made up. Well, as we
previously mentioned currencies are traded in pairs
and are each assigned a symbol. For the Japanese Yen
it is JPY, for the Pounds Sterling it is GBP, for
Euro it is EUR and for the Swiss Frank it is CHF.
So, EUR/USD would be Euro-Dollar pair. GBP/USD would
be pounds Sterling-Dollar pair and USD/CHF would be
Dollar-Swiss Franc pair and so on. You will always
see the USD quoted first with few exceptions such
as Pounds Sterling, EuroDollar, Australia Dollar and
New Zealand Dollar. The first international-currency quoted is called
the base currency. Have a look below for some example.

Currency Symbol Currency Pair

EUR/USD

Euro / US Dollar

GBP/USD

Pounds Sterling/ US Dollar

USD/JPY

US Dollar / Japanese Yen

USD/CHF

US Dollar / Swiss Franc

USD/CAD

US Dollar / Canadian Dollar

AUD/USD

Australian Dollar / US Dollar

NZD/USD

New Zealand Dollar / US Dollar

When you see IXFX and FX quotes you will actually see two
numbers. The first number is called the bid and the
second number is called the offer (sometimes called
the ASK). If we use the EUR/USD as an example you
might see 0.9950/0.9955 the first number 0.9950 is
the bid price and is the price traders are prepared
to buy Euros against the USD Dollar. The second number
0.9955 is the offer price and is the price traders
are prepared to sell the Euro against the US Dollar.
These quotes are sometimes abbreviated to the last
two digits of the currency such as 50/55. Each broker
has its own convention and some will quote the full
number and others will show only the last two. You
will also notice that there is a difference between
the bid and the offer price and that is called the
spread. For the four major currencies the spread is
normally 5 give or take a pip (will explain pips later)

To carry on from the symbol conventions and using
our previous EUR quote of 0.9950 bid, that means that
1 Euro = 0.9950 US Dollars. In another example if
we used the USD/CAD 1.4500 that would mean that 1
US Dollar = 1.4500 Canadian Dollars.

The most common increment of currencies is the PIP.
If the EUR/USD moves from 0.9550 to 0.9551 that is
one Pip. A pip is the last decimal place of a quotation.
The Pip or POINT as it is sometimes referred to depending
on context is how we will measure our profit or loss.

As each currency has its own value it is necessary
to calculate the value of a pip for that particular
currency. We also want a constant so we will assume
that we want to convert everything to US Dollars.
In currencies where the US Dollar is quoted first
the calculation would be as follows.

Example JPY rate of 116.73 (notice the JPY only goes
to two decimal places, most of the other currencies
have four decimal places)

In the case of the JPY 1 pip would be .01 therefore

USD/JPY: (.01 divided by exchange rate = pip value)
so .01/116.73=0.0000856 it looks like a big number
but later we will discuss lot (contract) size.

In the case where the U.S. Dollar is not quoted first
and we want to get to the U.S. Dollar value we have
to add one more step.

EUR/USD: (0.0001 divided by exchange rate = pip value)
so .0001/0.9887 = EUR 0.0001011 but we want to get
back to US Dollars so we add another little calculation
which is EUR X Exchange rate so 0.0001011 X 0.9887
= 0.0000999 when rounded up it would be 0.0001.

GBP/USD: (0.0001 divided by exchange rate = pip value)
so 0.0001/1.5506 = GBP 0.0000644 but we want to get
back to US Dollars so we add another little calculation
which is GBP X Exchange rate so 0.0000644 X 1.5506
= 0.0000998 when rounded up it would be 0.0001.

By this time you might be rolling your eyes back
and thinking do I really need to work all this out
and the answer is no. Nearly all the brokers you will
deal with will work all this out for you. They may
have slightly different conventions but it is all
done automatically. It is good however for you to
know how they work it out. In the next section we
will be discussing how these seemingly insignificant
amounts can add up.

More On Market Mechanics

Spot Forex is traditionally traded in lots also referred
to as contracts. The standard size for a lot is $100,000.
In the last few years a mini lot size has been introduced
of $10,000 and this again may change in the years
to come. As we mentioned on the previous page currencies
are measured in pips, which is the smallest increment
of that currency. To take advantage of these tiny
increments it is desirable to trade large amounts
of a particular currency in order to see any significant
profit or loss. We shall cover leverage later but
for the time being let's assume we will be using $100,000
lot size. We will now recalculate some examples to
see how it effects the pip value.

USD/JPY at an exchange rate of 116.73

(.01/116.73) X $100,000 = $8.56 per pip

USD/CHF at an exchange rate of 1.4840

(0.0001/1.4840) X $100,000 = $6.73 per pip

In cases where the US Dollar is not quoted first
the formula is slightly different.

EUR/USD at an exchange rate of 0.9887

(0.0001/ 0.9887) X EUR 100,000 = EUR 10.11 to get
back to US Dollars we add a further step

As we said earlier your broker may have a different
convention for calculating pip value relative to lot
size but however they do it they will be able to tell
you what the pip value for the currency you are trading
is at that particular time. Remember that as the market
moves so will the pip value depending on what currency
you trade.

So now we know how to calculate pip value lets have
a look at how you work out your profit or loss. Let's
assume you want to buy US Dollars and Sell Japanese
Yen. The rate you are quoted is 116.70/116.75 because
you are buying the US you will be working on the 116.75,
the rate at which traders are prepared to sell. So
you buy 1 lot of $100,000 at 116.75. A few hours later
the price moves to 116.95 and you decide to close
your trade. You ask for a new quote and are quoted
116.95/117.00 as you are now closing your trade and
you initially bought to enter the trade you now sell
in order to close the trade and you take 116.95 the
price traders are prepared to buy at. The difference
between 116.75 and 116.95 is .20 or 20 pips. Using
our formula from before, we now have (.01/116.95)
X $100,000 = $8.55 per pip X 20 pips =$171

In the case of the EUR/USD you decide to sell the
EUR and are quoted 0.9885/0.9890 you take 0.9885.
Now don't get confused here. Remember you are now
selling and you need a buyer. The buyer is biding
0.9885 and that is what you take. A few hours later
the EUR moves to 0.9805 and you ask for a quote. You
are quoted 0.9805/0.9810 and you take 0.9810. You
originally sold EUR to open the trade and now to close
the trade you must buy back your position. In order
to buy back your position you take the price traders
are prepared to sell at which is 0.9810. The difference
between 0.9810 and 0.9885 is 0.0075 or 75 pips. Using
the formula from before, we now have (.0001/0.9810)
X EUR 100,000 = EUR10.19: EUR 10.19 X Exchange rate
0.9810 =$9.99($10) so 75 X $10 = $750.

To reiterate what has gone before, when you enter
or exit a trade at some point your are subject to
the spread in the bid/offer quote. As a rule of thumb
when you buy a currency you will use the offer price
and when you sell you will use the bid price. So when
you buy a currency you pay the spread as you enter
the trade but not as you exit and when you sell a
currency you pay no spread when you enter but only
when you exit.

Leverage

Leverage financed with credit, such as that purchased
on a margin account is very common in Forex. A margined
account is a leverage able account in which Forex can
be purchased for a combination of cash or collateral
depending what your brokers will accept. The loan(leverage)
in the margined account is collateralized by your
initial margin (deposit), if the value of the trade
(position) drops sufficiently, the broker will ask
you to either put in more cash, or sell a portion
of your position or even close your position. Margin
rules may be regulated in some countries, but margin
requirements and interest vary among broker/dealers
so always check with the company you are dealing with
to ensure you understand their policy.

Up until this point you are probably wondering how
a small investor can trade such large amounts of money
(positions). The amount of leverage you use will depend
on your broker and what you feel comfortable with.
There was a time when it was difficult to find companies
prepared to offer margined accounts but nowadays you
can get leverage from a high as 1% with some brokerages.
This means you could control $100,000 with only $1,000.

Typically the broker will have a minimum account
size also known as account margin or initial margin
e.g. $10,000. Once you have deposited your money you
will then be able to trade. The broker will also stipulate
how much they require per position (lot) traded. In
the example above for every $1,000 you have you can
take a lot of $100,000 so if you have $5,000 they
may allow you to trade up to $500,00 of forex.

The minimum security (Margin) for each lot will very
from broker to broker. In the example above the broker
required a one percent margin. This means that for
every $100,000 traded the broker wanted $1,000 as
security on the position. Margin call is also something
that you will have to be aware of. If for any reason
the broker thinks that your position is in danger
e.g. you have a position of $100,000 with a margin
of one percent ($1,000) and your losses are approaching
your margin ($1,000). He will call you and either
ask you to deposit more money, or close your position
to limit your risk and his risk. If you are going
to trade on a margin account it is imperative that
you talk with your broker first to find out what their
polices are on this type of accounts.

Variation Margin is also very important. Variation
margin is the amount of profit or loss your account
is showing on open positions. Let's say you have just
deposited $10,000 with your broker. You take 5 lots
of USD/JPY which is $500,000. To secure this the broker
needs $5,000 (1%). The trade goes bad and your losses
equal $5001, your broker may do a margin call. The
reason he may do a margin call is that even though
you still have $4,999 in your account the broker needs
that as security and allowing you to use it could
endanger yourself and him.

Another way to look at it is if you have an account of
say $10,000 and you have a 1 lot ($100,000) position. That's $1,000
assuming a (1% margin) is no longer available for
you to trade. The money still belongs to you but for
the time you are margined the broker needs that as
security. Another point of note is that some brokers
may require a higher margin at the weekends. This
may take the form of 1% margin during the week and
if you intend to hold the position over the weekend
it may rise to 2% or higher. Also in the example we
have used a 1% margin. This is by no means standard.
I have seen as high as 0.5% and many between 3%-5%
margin. It all depends on your broker.

There have been many discussions on the topic of
margin and some argue that too much margin is dangerous.
This is a point for the individual concerned. The
important thing to remember as with all trading is
that you thoroughly understand your brokers policies
on the subject and you are comfortable with and understand
your risk.

Roll overs

Even though the mighty US dominates many markets
most of Spot Forex is still traded thru the London
commodity exchange in the U.K. So for our next
description we will use London time. Most deals in FX
Forex are done as Spot deals. Spot deals are nearly
always due for settlement 2 business days day later.
This is referred to as the value date or delivery date. On that date the
counter parties take delivery of the currency they have sold or bought.

In Spot FX the majority of the time the end of the
business day is 21:59 (London time). Any positions
still open at this time are automatically rolled over
to the next business day, which again finishes at
21:59. This is necessary to avoid the actual delivery
of the currency. As Spot FX is predominantly speculative
most of the time the trades never wish to actually
take delivery of the actual currency. They will instruct
the brokerage to always rollover their position. Many
of the brokers nowadays do this automatically and
it will be in their polices and procedures. The act
of rolling the currency pair over is known as tom.next
which, stands for tomorrow and the next day. Just
to go over this again, your broker will automatically
rollover your position unless you instruct him that
you actually want delivery of the currency. Another
point noting is that most leveraged accounts are unable
to actual deliver of the currency as there is insufficient
capital there to cover the transaction.

Remember that if you are trading on margin, you have
in effect got a loan from your broker for the amount
you are trading. If you had a 1 lot position you broker
has advanced you the $100,000 even though you did
not actually have $100,000. The broker will normally
charge you the interest differential between the two
currencies if you rollover your position. This normally
only happens if you have rolled over the position
and not if you open and close the position within
the same business day.

To calculate the broker's interest he will normally
close your position at the end of the business day
and again reopen a new position almost simultaneously.
You open a 1 lot ($100,000) EUR/USD position on Monday
15th at 11:00 at an exchange rate of 0.9950. During
the day the rate fluctuates and at 22:00 the rate
is 0.9975. The broker closes your position and reopens
a new position with a different value date. The new
position was opened at 0.9976 a 1 pip difference.
The 1 pip deference reflects the difference in interest
rates between the US Dollar and the Euro. In our example
your are long Euro and short US Dollar. As the US
Dollar in the example has a higher interest rate than
the Euro you pay the premium of 1 pip.

Now the good news. If you had the reverse position
and you were short Euros and long US Dollars you would
gain the interest differential of 1 pip. If the first
named currency has an overnight interest rate lower
than the second currency then you will pay that interest
differential if you bought that currency. If the first
named currency has a higher interest rate than the
second currency then you will gain the interest differential.

To simplify the above. If you are long (bought) a
particular currency and that currency has a higher
overnight interest rate you will gain. If you are
short (sold) the currency with a higher overnight
interest rate then you will lose the difference.

I would like to emphasis here that although we are
going a little in-depth to explain how all this works,
your broker will calculate all this for you. The purpose
of this book is just to give you an overview of how
the forex market works.

Accounts

Although the movement today is towards all transaction
eventually finishing in a profit and loss in US Dollars
it is important to realize that your profit or loss
may not actually be in US Dollars. From my observation
the trend is more pronounced in the US as you would
expect. Most US based traders assume they will see
their balance at the end of each day in US Dollars.
I have even spoken with some traders who are oblivious
to the fact the their profit might have actually been
in Japanese Yen.

Let me explain a little more. You sell (go short)
USD/JPY and as such are short USD and Long (bought)
JPY. You enter the trade at 116.10 and exit 116.90.
You in fact made 80,000 Japanese Yen (1 lot traded)
not US Dollars. If you traded all four major currencies
against the US Dollar you would in fact have made
or lose in EUR, GPY, JPY and CHF. This might give
you a ledger balance at the end of the day or month
with four different currencies. This is common in
London. They will stay in that currency until you
instruct the broker to exchange the currency you have
a profit or loss into your own base currency. This
actually happened to me. After dealing with mainly
US based brokers it had never occurred to me that
my statement would be in anything other than US Dollars.
This can work for you or against you depending on
the rate of exchange when you change back into your
home currency. Once I knew the convention I simply
instructed the broker to change my profit or loss
into US Dollars when I closed my position. It is worth
checking how your broker approaches this and simply
ask them how they handle it. A small point but worth
noting.

It's a sad fact that for many years the forex market
largely remained unregulated. Even today there are
many countries that still don't regulate companies
that trade forex. London has been regulated for many
years and the US is now getting its act together and
has also started regulating companies dealing forex.
It was only recently in the US you could with no more
than an Internet site and a few thousand dollars set
up your own forex operation and give the impression
that you were larger than you are. I am all for the
entrepreneurial flair and everyone need to start somewhere
but when dealing with people's money it is imperative
that the company you choose is solid.

Preferably you want a company that is regulated in
the country that it operates, insured or bonded and
has some kind of track recorded. I cannot advise you
on which broker you should use as there are just to
many variables to each person, but as a rule of thumb,
nearly all countries have some kind of regulatory
authority who will be able to advise you. Most of
the regulatory authorities will have a list of brokers
that fall with their jurisdiction and will give you
a list. They probably wont tell whom to use but at
least if the list came from them you can have some
confidence in those companies. Once you have a list
give a few of them a call, see who you feel comfortable
with, ask for them to send you their polices and procedures.
If you live near where your broker is based, go spend
the day with him. I have been to many brokerages just
to check them out. It will give you a chance to see
their operation and meet their team.

This brings up another interesting point. When you
open an account with a broker you will have to fill
in some forms basically stating your acceptance of
their polices. This can range from a 1 page document
to something resembling a book. Take the time to read
through these documents and make a list of things
you don't understand or want explained. Most reputable
companies will be happy to spend some time with you
on this. Your involvement with your broker is largely
up to you. As a forex trader you will probably spend
long hours staring at the screen without talking to
anyone. You may be the sort of person who likes this
or you may be the sort of person who likes to chat
with the dealer in the trading room. You will normally
get a call once a week or once a month from someone
in the brokerage asking if everything is OK.

Statements

Before we move on to account statements I just want
to touch on segregation of funds. In times past there
was a danger that traders who deposited money with
their broker who did not segregate their clients money
from their own companies money were at some risk.
The problem arose if the broker misused the deposited
funds to either reinvest or otherwise manipulated
these deposits to enhance their own standing. There
were also instances were the broker became insolvent
and many complications ensued as to what was the clients
money and what was the broker's money. With the advent
of regulation most broker now segregate their clients
funds from the brokerage funds. Deposits are normally
held with banks or other large financial institution
that are also regulated and bonded or insured. This
protects you money should anything happen to your
broker. The deposit taking institution is normally
aware that these deposits are client's funds. Depending
on regulation in the particular country you live,
each client may have their own segregated account
or for smaller depositors they may be pooled. The
point is that segregation of funds is a safeguard.
Ask your broker if your funds are segregated and who
actually has your money.

Just as with a bank you should are entitled to interest
on the money you have on deposit. Some broker may
stipulate that interest is only payable on accounts
over a certain amount but the trend today is that
you will earn interest on any amount you have that
is not being used to cover your margin. Your broker
is probably not the most competitive place to earn
interest but that should not be the point of having
your money with him in the first place. Payment on
your account that is not being used and segregation
of funds all go to show the reputability of the company
you are dealing with.

In this section I will discuss briefly the basic
account statement. I have to keep this basic as there
are as many flavors of account statements as you can
imagine. Just about every broker has their own way
of presenting this. The most important thing is to
know where you stand at the end of each day or week.
Just because your broker is Internet based and has
all the bells and whistles does not mean they are
infallible. Many of the actions taken before information
is imputed are still done by hand and if humans are
involved there will be a mistake at some point. The
responsibility lies with you. It is your money so
make sure that all the transactions are correct.

Normally there is a ticket or docket number to help
identify the trade. You will nearly always find the
time and date of the trade. The value date if the
currency were to be delivered. You should always see
the direction of the trade, buy or sell (Long or Short).
The amount and rate you bought or sold. Balance to
let you know if you made a profit or a loss. You should
also see any open positions you may have and the margin
requirements for that position. A lot of the more
modern systems will show your open position as though
it has been closed just to give you an up to the minute
balance.

The Main Players - Central Banks And Governments

Policies that are implemented by governments and
central banks can play a major roll in the FX market.
Central banks can play an important part in controlling
the country's money supply to insure financial stability.

Banks - A large part of FX turnover is from banks.
Large banks can literally trade billions of dollars
daily. This can take the form of a service to their
customers or they themselves speculate on the FX market.

Hedge Funds - As we know the FX market can be extremely
liquid which is why it can be desirable to trade.
Hedge Funds have increasingly allocated portions of
their portfolios to speculate on the FX market. Another
advantage Hedge Funds can utilize is a much higher
degree of leverage than would typically be found in
the equity markets.

Corporate Businesses - The FX market mainstay is
that of international trade. Many companies have to
import or exports goods to different countries all
around the world. Payment for these goods and services
may be made and received in different currencies.
Many billions of dollars are exchanges daily to facilitate
trade. The timing of those transactions can dramatically
affect a company's balance sheet.

The Man In The Street - Although you may not think
it the man in the street also plays a part in toady's
IXFX world. Every time he goes on holiday overseas he
normally need to purchase that country's currency
and again change it back into his own currency once
he returns. Unwittingly he is in fact trading currencies.
He may also purchase goods and services whilst overseas
and his credit card company has to convert those sales
back into his base currency in order to charge him.

Speculators And Investors - We shall differentiate
speculator from investors here with the definition
that an investor has a much longer time horizon in
which he expects his investment to yield a profit.
Regardless of the difference both speculators and
investors will approach the FX market to exploit the
movement in currency pairs. They both will have their
reason for believing a particular currency will perform
better or worse as the case may be and will buy or
sell accordingly. They may decide that the Euro will
appreciate against the US Dollar and take what is
called a long position in Euro. If the Euro does in
fact gain ground against the US Dollar they will have
made a profit.

What Next

Well now we have a basic understanding of how the
FX market works and who the main players are, what
next? You are now going to have to decide the best
way to trade the market. The two most common approaches
are that of fundamental analysis and technical analysis.

Fundamental analysis concentrates on the forces of
supply and demand for a given security. This approach
examines all the factors that determine the price
of a security and the real value of that security.
This is referred to as the intrinsic value. If the
intrinsic value is below the market price then there
is an opportunity to buy and if the market is above
the intrinsic price then there is an opportunity to
sell.

Technical analysis is the study of market action,
mainly through the use of charts and indicators to
forecast the future price of a security. There are
three main points that a technical analyst applies.
A. Market action discounts everything. Regardless
of what the fundamentals are saying, the price you
see is the price you get. B. The price of a given
security moves in trends. C. The historical trend
of a security will tend to repeat.

Of all of the above things the most important of
them is point A. The tools of the technical analyst
are indicators, patterns and systems. These tools
are applied to charts. Moving averages, support and
resistance lines, envelopes, Bollinger bands and momentum
are all examples of indicators.

There are many ways to skin a cat as the saying goes
but fundamental and technical analysis are the two
most popular ways of trading FX.

My own preferred approach is that of technical analysis. by Mark McRae

Commodity Traders trading knowledge guide and information on how to successfully trade commodity/futures for profits.